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Economic optimism riding high, but Bank of Canada biding time on rates

The Canadian flag flies outside the Bank of Canada building in Ottawa, Ontario, Canada, on Wednesday, Oct. 23, 2013.

Patrick Doyle/Bloomberg

Canadians may be in for a pleasant surprise when Canada's fourth-quarter gross domestic product report comes out this week. But the data will come one day too late to colour the Bank of Canada's interest-rate decision.

Statistics Canada will release GDP figures for December and for the fourth quarter on Thursday morning. Optimism about the likely numbers is riding high, thanks to a generally strong string of key indicators leading up to the GDP report. The consensus among economists is that real GDP grew at an annualized rate of close to 2 per cent in the quarter, well above the Bank of Canada's most recent estimate of 1.5 per cent, published in mid-January.

The results are expected to have been propelled by a brisk December economy, which economists believe grew by about 0.3 per cent month over month, building on November's 0.4-per-cent gain. The evidence of the month's strength lies in better-than-expected results for several key contributors to GDP: Manufacturing sales jumped 2.3 per cent month over month. Merchandise exports were up 0.8 per cent, contributing to Canada's second straight monthly trade surplus after 25 straight deficits. Employment surged by 46,000 jobs. Wholesale trade rose 0.7 per cent. (The only key economic cylinder to misfire in the month was retail sales, which fell 0.5 per cent on a seasonally adjusted basis, after four straight months of increases.)

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Importantly for the Bank of Canada, the apparently solid finish to 2016 has set the Canadian economy on a trajectory for an even stronger 2017. But while the central bank is well aware of the generally encouraging flow of economic data in December, it won't have the GDP figures in hand when it makes its rate decision on Wednesday morning.

This is one of the bank's rate decisions that lands in between quarterly Monetary Policy Reports, so the bank's only communication will be its brief rate announcement (a handful of paragraphs); there's no accompanying news conference, and no update of the bank's economic projections. While the bank is widely expected to keep its key interest rate at 0.5 per cent, where it has sat since July of 2015, observers will parse the announcement carefully to see if the upbeat economic data have changed the bank's tone about the outlook for growth this year and, by extension, the possibility of a rate increase in the next 12 months.

The lack of GDP data might actually buy the central bank some time. While the economy has recently outpaced its forecasts, the bank has remained cautious, focusing on the still sizable excess capacity in the Canadian economy (often referred to as the output gap) and on the looming risks to the economic outlook, especially on the U.S. growth and trade front under the new Trump administration. Without having to explain away a set of better-than-expected GDP figures, the bank might more comfortably stick to its message, implying that any interest-rate increases are still far on the horizon – although the recent solid economic data may have taken a near-term rate cut off the table.

Later in the week, the Bank of Canada will have a couple of opportunities to elaborate on its policy stance. Deputy governor Tim Lane, the longest-serving member of the bank's Governing Council, gives a speech in Montreal the day after the rate announcement. And senior deputy governor Carolyn Wilkins, Mr. Poloz's second-in-command, takes part in a panel discussion at Yale University Law School on Friday.

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Observers will be interested to hear the central bank's reaction to the past week's Canadian consumer price index report, which showed that inflation hit a 27-month high in January, and was much higher than most experts had expected. At 2.1 per cent, the inflation rate surpassed the Bank of Canada's target of 2 per cent – a target that serves as the formal guide for setting interest-rate policy.

But economists expect the central bank to tread cautiously on the inflation front, likely stressing that the January surge above the bank's target was the result of a relatively short-term spike in gasoline costs, and not a sign of building underlying inflationary pressures in the economy.

"The focus will continue to be on the output gap, and notwithstanding strong employment growth, a soft trend in hours worked suggests that there's still ample slack in the Canadian economy. As such, don't look for the Bank of Canada to change its tune–or its stance in monetary policy–anytime soon," said Canadian Imperial Bank of Commerce economist Nick Exarhos in a research report.

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More

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